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Optical/IP

Waiting for Cisco Sunshine

If Cisco Systems Inc. (Nasdaq: CSCO) misses its expected numbers in announcing its fiscal third quarter 2004 earnings tonight, it will shock the networking world. Wall Street's research community is nearly unanimous in expecting a good quarter.

A review of eight research notes from sell-side firms in the Light Reading inbox shows them all shouting almost exactly the same thing in unison: "Great quarter, guys!" Most of the analysts see Cisco either meeting or slightly beating the estimates for the quarter.

If Cisco does improve on its numbers significantly, it could be at the expense of major competitors. Foundry Networks Inc. (Nasdaq: FDRY) recently reported disappointing results (see Foundry Stock Slides on Q1 Results ); Riverstone Networks Inc. is grappling with a major management shift (see Riverstone Begins New Chapter); and Extreme Networks Inc. (Nasdaq: EXTR) is going through a long struggle to get back to profitability (see Extreme Narrows Losses).

Steve Kamman, an analyst with CIBC World Markets, recently concluded in a research report that Cisco may be accelerating its growth rate in enterprise networking through the expansion of its market share.

"We expect Cisco's growth to come at other players' expense. Non-Cisco players' revenues to decline by about 9 percent between 2004 and 2009, largely reflecting market share losses to Cisco," wrote Kamman.

Therefore, says Kamman, Cisco should show growth that is faster than the overall market for LAN equipment, with a 4 percent to 5 percent CAGR through 2009.

There are still plenty of questions about Cisco's progress in the telecom market, where it's been quiet lately. Right now all eyes are on the HFR, its next-generation router product, which nobody expects to be announced until next month (see Cisco Sprints Ahead With HFR, HFR, Where Are You?, and Source: Cisco's HFR Tips the Scales). Another key in the telecom market is edge routing, where Cisco is in a big battle with Juniper Networks Inc. (Nasdaq: JNPR), which has shown some improved results lately (see Juniper Profits in Q1).

Here are some specifics to watch for: Revenue: Most analysts are expecting Cisco to report something at the top of the range of its guidance, which is a 1 percent to 3 percent improvement over its second-quarter 2004 revenues. This would put revenue in the range of $5.45 billion to $5.56 billion.

Historically, this has been Cisco’s weakest quarter throughout the year, so anything it can do to demonstrate growth will be received well.

Profit & margins: The bulk of estimates for earnings are $0.18 a share. As always, profit margins are key, and they are closely watched as a sign of the overall health of the quarter. If the market climate is improving, Cisco should be able to improve on last quarter’s gross margins, which were 68.5 percent. Analysts expect to see the same. Coming in below 68 percent would be seen as a disappointment, indicating pricing pressure.

Hot products: Hot new product areas will be key to Cisco's growth, and some of these include 10-Gig Ethernet, edge routing, and VOIP gear. With the packetization of telecom networks moving forward, these market segments are key to Cisco’s growth. Investors would like to hear news about these markets picking up steam to feel confident that the rebound is for real.

Linksys: Cisco bought Linksys in early 2003 (see Cisco Buying Linksys for $500M), hoping to improve its sales, with the tradeoff being that Linksys’s mostly consumer-targeted wireless products yield lower profit margins than Cisco’s higher-end networking gear. The key thing to watch for here is whether Linksys is living up to its expectations of fueling overall revenue growth. Slowing revenue from Linksys could cause problems in the future. Sales close to $300 million or more will be considered blockbuster, while anything under $250 million from Linksys would be a disappontment. Book-to-bill ratio: This figure, the ratio of orders received (booked) to those shipped (billed), is traditionally an indicator of what's in the business pipeline. However, Cisco ships many of the orders it receives in the same quarter, which would not be reflected in the book-to-bill ratio. An example of this is that Cisco reported a book-to-bill ratio of less than 1 in the second quarter, yet it still expects to improve on revenue.

Future guidance: With the third quarter of 2004 being Cisco's historically weakest quarter, the market will want to hear some upbeat guidance going forward. Anything sounding "flat" will be perceived as a negative. The market and investors want to hear about growth.

The Chambers factor: Cisco CEO John Chambers is such a closely watched business leader that he holds sway over virtually the entire technology market. The tone and mood of his words will be monitored closely -- and reflected in the markets. If he is unusually neutral or even cautious it could come as a disappointment to investors who have already priced in a significant recovery in the networking equipment market.

— R. Scott Raynovich, US Editor, Light Reading

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